Chapter One

Fundamentals of Project Planning and Administration

1.1 Meaning and definition of project
What is a project?

There is no one comprehensive definition for a project. Its definition varies from author to
author, from organization to organization, and based on the nature, objective and other
characteristics of the project. As a result you may find several definitions of a project in the
literature some of which are provided below.

 Project is a temporary organization to which resources are assigned to undertake a

unique, novel and transient endeavor managing the inherent uncertainty and need for
integration in order to deliver beneficial objectives of change (Turner and Müller, 2003).
 A project is a temporary endeavor undertaken to create a unique product, service or
result (PMI, 2004).
 A project is defined as one shot, time tested, goal directed, major undertaking requiring
the commitment of varied skills and resources.

 A project also described as a combination of human and non human resources pulled
together in a temporary organization to achieve a specified purpose.

A major misconception about a project is relating it to only construction or creation of such

physical facilities as buildings, roads and dams. However, project may involve intangible things
such as creation of awareness (e.g. about HIV/AIDS), eradication of diseases (e.g. polio
vaccination), combating harmful practices (e.g. genital mutilation) and capacity building (e.g.
training to enhance service delivery capabilities of public sector employees). Thus, projects may
range from physical or technical (construction of physical facilities) to mixed (involving both
physical and nonphysical things) to nonphysical (dealing purely with behavioral aspects of an
organization). Regardless of its type and complexity, a project can be more explained in terms of
its characteristics, discussed in the next section, which distinguish it from other organizations
and their ongoing activities.

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Implementation of project needs resources or inputs. Every project converts the given inputs in to
outputs through the process on implementation. The outputs in the short run lead to outcome, which
in the long run, should result in impact. On a critical examination, we see that each project has
feedback mechanism to evaluate its performance and reviews its tasks and objectives.

Therefore, a project can be defined as a complex of non-routine activities that must be

completed with a set amount of resources and within a set time limit.

A project can also consider being any a series of activities and tasks that:

- Have a specific objective to be completed within certain specifications

- Have defined start and end dates

- Have funding limits

- Consume scarce resources (i.e. financial, human, and materials resources).

 A Project can also defined as an entire set of activities involved in conceiving, planning,
appraising, implementing, monitoring, and evaluating an economic or social undertaking
which involves the employment of scarce resources to create products or services.

1.2 Characteristics of a Project

According to Turner and Müller (2003), PMBOK (2004) and Nicholas and Steyn (2008), the
following features characterize a project:

Temporary – Project is not a going concern. It rather is a one-time non-routine activity that has a
definite beginning and a definite end. Each project is an ad hoc organization of human, physical
and financial resources, and activities assembled to accomplish a goal within a scheduled time
frame. Project resources and activities are disbanded when the goals of the project are achieved
or when it becomes clear that the project goals will not or cannot be met or the need for the
project no longer exists. In practice, however, some projects last longer than we expect them
which makes them similar to permanent organizations, thus, seriously challenges the idea that
projects are temporary organizations. Turner (2006) argued that the intention with a project is
that it should be temporary and disbanded when it achieved or if it failed to achieve the change

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for which it was created to bring. The intention with non-project organizations, however, is that
they should be permanent. We need to note that temporary does not necessarily mean that a
project has short duration and it also does not generally apply to the products, services or results
created by the project, which, in many projects, are expected to last long.

ii. Unique – Projects are said to be as unique as fingerprints. A project is considered to be a

unique endeavour in various terms including its size, complexity, duration, timing, location,
stakeholders, design, objective and other several variables. For example, even in a project such
as construction of house, variables such as design, location, materials used, people involved and
timing make it unique. Besides, project uniqueness means that each project is a distinct and
separate entity which can be planned, financed and implemented as a unit. Uniqueness, however,
does not mean that there is no similarity between projects; it rather means that their differences
often outweigh their similarities. In relation to the level of routineness of a project, Turner (2004)
identified four types of projects, namely, repeaters which are virtually routine batch processing
type; runners which are quite similar to previously undertaken projects; strangers which are
essentially different from previously undertaken projects but with some common elements; and
aliens which are unlike any of the projects done before.
iii. Resources – Project involves different resources drawn from different functions, organizations
and professions that cross beyond the ordinary boundaries of an organization and its functional units
(Nicholas and Steyn, 2008). An exception to this could be a project in a portfolio of projects which
share common resource pool. Project resources include human, material, financial and information.
A typical project may involve organizations such as the owner, user, contractor, supplier and
financier. These organizations may be involved in a project through their different functional units
and contribute, among others, human resources from different professions including engineering,
architecture, accounting and environment, to mention some.
iv. Beneficial changes – Turner (2006b) stated that a project is meant to produce an output which in
its turn is meant to help its owner to achieve beneficial outcome. Collectively, project outputs and
outcomes are identified as goals. Thus, each project has a specific goal that can be identified,
quantified or valued. A distinction is usually made of the output and outcomes of a project. The
output of a project refers to the tangible or intangible thing created by undertaking the project and the
goods and services that this thing delivers. For example, the output of a construction project may be a
multi-story building and accommodation services it renders. The output of a training project may

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include creation of awareness of say harmful traditional practices and not to practice such harmful
traditions. Project outcome, on the other hand, refers to the very purpose for implementing a project
and the rationale for producing project output. This could be improved health, better quality of live
and creation and maximization of wealth of project stakeholders. The intermediate outcomes of a
project could be financial (e.g. reduced operating costs and increased revenue) and/or non-financial
benefits (e.g. enhanced product or service quality and increased market share) which the owner of a
project can enjoy from using the output of a project.
A key point to note in relation to project goals is that they should be stated in a way that
facilitates measurement of achievements. The general rule is that project goals should be
SMART – an acronym for:
 Specific – well defined and clear to anyone that has a basic knowledge of the project,

 Measurable – how do we know how far away completion is and when it has been
achieved?
 Action-oriented – indicate what should be done to achieve the objective,
 Reliable/achievable – do we have the resources (human, financial, material, information,
time) to make the goal happen? Is the objective achievable with the available resources
and timeframe, and
 Time-based – it should identify a definite target date for completion and/or frequencies
for specific action steps that are important for achieving the goal on/within a specific
time period.

Classification of Projects
Projects may be classified into different categories in various ways as indicated below. However,
note that the classification bases are not mutually exclusive. For instance, government may
undertake an educational project over some ten years period of time financed by resources from
equity, loan and/or grant.
i) Ownership – this is based on who owns the project with no reference to the beneficiaries from
the project. Accordingly, we may have private sector projects undertaken by investors with the
main objective of earning profit and public sector projects undertaken by national, regional or
local government entities, non-governmental not-for-profit organizations with the objective of
improving the livelihood of citizens without expecting any return from citizens consuming the
goods and services of these projects.

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Projects undertaken by public sector organizations, especially in developing countries, are
commonly identified as development projects because such projects are primarily meant to bring
development to a nation, thus, enhance the living standards of its citizens. The term development
project is also used by the private sector to mean projects involved in product and/or process
development. A third group of projects classified based on ownership are non-institutional
projects such as those being undertaken by individuals including marriage, getting driving
license, etc.
ii) Source of fund – this is based on whether the project is financed by equity, loan and/or
grant. For example, most projects undertaken by public sector entities are financed by external
assistance and loan while projects undertaken by private sector entities use some combination of
equity and loan financing.

iii) Time horizon – this is based on the time period the project takes to become operational.
Though highly subjective, the usual classification of projects according to time horizon is this:
short-term projects cover less than 5-year period of time; medium-term projects cover between
5 to 10 years; and long-term projects cover above 10-year period of time.
Iv) Sectoral – this is based on the economic sector the project is involved in and may include
such groupings as agriculture, industry, mining, health, education, transport and
communication, financial service, defense, etc.

v) Amount of resources required – although difficult to determine the amount, projects can be
divided in terms of the amount of resources (e.g. financial and human) deployed as small-,
medium- and large-scale.

vi) Assessment of benefits – in terms of the ways one may be able to assess the benefits
obtainable; projects may be classified as quantifiable and non-quantifiable. Quantifiable
projects are those to which plausible assessment of benefits can be made (e.g. industrial and
mining projects) while non-quantifiable projects are those projects to which application of
plausible quantitative assessments of benefits is not possible (e.g. health and education projects).

vii) How resources are committed – this includes new investment project which involve
establishment of new production unit; expansion investment which involves repeating or

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extending an existing production unit; and updating investment which involves replacing or
changing some elements of an existing production unit to modernize and improve it.

1.3 Project Planning and Analysis

Definition
Project planning and analysis is a detailed examination of viability of a project in terms of such
variables as commercial, technical, environmental, financial and social. It is meant to provide
information needed by decision makers to reach at an informed and rational choice of projects
for implementation. It is usually done by a party other than the decision maker called the analyst.

Importance
Comprehensive development programs at national level are composed of a variety of projects. It
is vital for the success of development goals that projects at micro-level are found to be both
feasible and desirable. The basic economic problem facing all countries is that of allocating
limited resources (such as labor, capital, natural resources, as well as foreign currency) to a
variety of different uses (such as current production of consumer goods and public services as
against investment in infrastructure, industry, agriculture, or other sectors of the economy) in
such a way that the net benefit to the society is as large as possible. The same justification
applies to project planning and analysis in the private sector. All business organizations face
problem of allocating their scarce resource to available alternative projects. Project planning and
analysis help them to select the alternative that will bring more benefits than costs that is the
project that maximizes return to its shareholders.
Given the limited resources, project planning and analysis is one method of evaluating
alternatives in a convenient and comprehensible fashion to provide information for decision
makers to choose from among competing projects. In essence, project planning and analysis
assesses the benefits and costs of a project and reduces them to a common yardstick (e.g.
money). If project benefits exceed costs, measured by a common yardstick, the project is
acceptable, if not, the project should be rejected. Thus, the importance of project planning and
analysis rests on the:

 Fact that successful accomplishment of goals requires both desirable and feasible projects

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  Need to allocate scarce resources to competing uses or projects

 Need to ensure that costs of resources needed to implement and operate a project do
not exceed the benefits from having and utilizing the project

 Fact that it reduces costs and benefits associated with competing projects into a
common yardstick i.e. money, thus, it eases comparison and selection

Project and Plan

Development strategies are packages of ways and means by which available resources are put in
their best use in achieving specified objectives such as eradication of poverty. They are plans a
country uses to achieve its long-term and medium-term objectives. They have many programs
under them. The programs constitute projects that convert the resources to future benefits. The
projects refer to the actual commitment of scarce resources takes place. Hence project selection
is meaningful only when it is consistently placed within a broader development framework. This
framework is also the basis under which the projects’ costs and benefits will be assessed.

In order to simplify project planning and selection the development plans and policy should be
elaborated properly. They should outline the desired socio-economic patterns of development
and the objectives to be achieved in the long-term and medium term. Such development plans
and sectoral programs should not only assist the planning and selection of development projects
also they should guide the emphasis of private projects towards the attainment of the country
goals. For instance, a country trying to following an export led development strategy will design
as many projects as possible on infrastructure that foster exports and provide incentives to
private investors to design projects on the production of exportable commodities.
Project Plan
A project plan is "A formal, approved document used to guide both project execution and
project control. The primary uses of the project plan are to document planning assumptions and
decisions, facilitate communication among stakeholders, and document approved scope, cost,
and schedule baselines. A project plan may be summary or detailed."

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A project plan is alternatively defined as “a statement of how and when a project's objectives are
to be achieved, by showing the major products, milestones, activities and resources required on
the project." In some industries, particularly information technology, the term "project plan" can
to refer to a Gantt chart or other document that shows project activities along a timeline. While
common, this use is inaccurate. These types of documents are more accurately described as
project schedules and are only one component of a true project plan.
At a minimum, a project plan answers basic questions about the project:
Why? - What is the problem or value proposition addressed by the project? Why is it being
sponsored?
What? - What is the work that will be performed on the project? What are the major
products/deliverables?
Who? - Who will be involved and what will be their responsibilities within the project? How
will they be organized?
When? - What is the project timeline and when will particularly meaningful points, referred to
as milestones, be complete?
Project Planning
Project planning is part of project management, which relates to the use of schedules such as
Gantt charts to plan and subsequently report progress within the project environment. Initially,
the project scope is defined and the appropriate methods for completing the project are
determined. Following this step, the durations for the various tasks necessary to complete the
work are listed and grouped into a work breakdown structure. The logical dependencies between
tasks are defined using an activity network diagram that enables identification of the critical
path. Float or slack time in the schedule can be calculated using project management software.
Then the necessary resources can be estimated and costs for each activity can be allocated to
each resource, giving the total project cost. At this stage, the project plan may be optimized to
achieve the appropriate balance between resource usage and project duration to comply with the
project objectives. Once established and agreed, the plan becomes what is known as the baseline.
Progress will be measured against the baseline throughout the life of the project. Analyzing
progress compared to the baseline is known as earned value management

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1.4 Project Life Cycle
There tends to be a natural sequence in the way projects are planned and carried out. Before any
project is actually realized it goes through various planning phases Therefore, the different stages
through which project planning proceeds from inception to implementation are often called “the
project cycle”. It is the project’s life cycle through which it advances from infancy to maturity. The
main features of this process are information gathering, analysis, and decision making.
The stages or phases through which the project passes are necessary for its completion and they
constitute a specific sequence that is cyclical in nature identified as project life cycle. Dividing
project life cycle into phases helps in better management and control of a project. Therefore, projects
cycle is a self – renewing cycle in that new projects may grow out of the old ones in a continuous
process and self – sustaining cycle of activity.
Project life cycle models

Like the definitions of a project, there are different project life cycle models which differ in their
perspective, emphasis and level of detail. The commonly known models include the

A) World Bank project life cycle or sometimes called Baum Cycle (Baum, 1982)

B) Development projects Studies Authority (DPSA) Cycle

C) UNIDO project life cycle (Behrens and Hawranek, 1991)

Although, the aforementioned models use different terminologies and divide the project life
cycle into different number of phases, the very essence of project life cycle is that projects are
first identified in the form of ideas followed by different types of studies to determine their
feasibility, execution of the feasible one/s, use of the outputs of the project to deliver goods and
services (operating and maintain project output) and assessment of whether the projects support
the organization in achieving its goals.

A) World Bank Project Cycle (The Baum Cycle)

Project with the characteristics already outlined above typically run through at least several
separable stages of activity which can be thought of as constituting a definite sequence that some
author’s /institutions/ have called a project cycle. The first basic model of a project cycle is that

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of Baum (1970), which has been adopted by the World Bank and initially recognized four main
stages, namely.
1. Identification

2. Preparation

3. Appraisal and Selection

4. Implementation

At a later stage (in 1978) the author has added an additional stage called “Evaluation” which
usually closes the cycle as it gives rise to the identification of new projects. Thus making the
stages 5 in number. These processes can usefully be considered as a comprehensive sequence in
the sense that for the project that is implemented, each stage naturally follows the proceeding one
and leads on to the next. Throughout the project cycle the primary preoccupation of the analyst is
to consider alternatives, evaluate them, and to make decisions as to which of them should be
advanced to the next stage. Thus, each of Baum’s main stages are discussed briefly below
1. Identification
The first stage in the cycle is to find potential projects. Some sources of projects are given here.
Some may be “resource based” and stem from the opportunity to make profitable use of
available resources. Some projects may be “market based” arising from an identified demand in
home or overseas markets. Others may be “need-based” where the purpose is to try to make
available to all people in an area of minimal amounts of certain basic material requirements and
services. Well – informed technical specialists and local leaders are also common sources of
projects. Technical specialists will have identified many areas where they feel new investment
might be profitable, while local leaders may have suggestion about where investment might be
carried out. Ideas for new projects also come from proposals to extend existing programs.
In general, most projects start as an elementary idea. Eventually, some simple ideas are
elaborated into a form to which the title “project” can be formally applied.

2. Preparation (pre – feasibility or feasibility studies)

Once projects have been identified, there begins a process of progressively more detailed
preparation and analysis of project plans. At this stage the project is being seriously considered
as a definite investment action.

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Project preparation (project formulation) covers the establishment of technical, economic and
financial feasibility. Decisions have to be made on the scope of the project, location and site, soil
and hydrological requirements, project size (farm or factory size) etc

Resource base investigations are undertaken and alternative forms of projects are explored.
Complete technical specifications of distinct proposals accompanied by full details of financial
and economic costs and benefits are the outcome of the project preparation stage. The project
now exists as a set of tangible proposals.

Project design and formulation is an area in which local and international consultants are very
active especially for big project that cover large areas and have big budgets.

3. Appraisal
After a project has been prepared, it is generally appropriate for a critical review or an
independent appraisal to be conducted. This provides an opportunity to re-examine every aspect
of the project plan to assess whether the proposal is appropriate and sound before large sums are
committed.
Generally, internal government staffs only are used for this work and not consultants and
projects are appraised both in the field and at the desk level. Appraisals should cover at least
seven aspects of a project, each of which must have been given special consideration during the
project preparation phase:
a) Technical – here the appraisals concentrate in verifying whether what is proposed will work
in the way suggested or not.

b) Financial – the appraisals try to see if the requirements for money needed by the project have
been calculated property, their sources are all identified, and reasonable plans for their
repayment are made where necessary.

c) Commercial – the way the necessary inputs for the project are conceived to be supplied is
examined and the arrangements for the disposal of the products are verified.

d) Incentive – the appraisals see to it whether things are arranged in such a way that all those
whose participation is required will find it in their interest to take part in the project, at least to
the extent envisaged in the plan.

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e) Economic – the appraisal here tries to see whether what is proposed is good from the
viewpoint of the national economic development interest when all project effects (positive and
negative) are taken into account and check if all are correctly valued.

f) Managerial – this aspect of the appraisal examines if the capacity exists for operating the
project and see if those responsible ones can operate it satisfactorily . Moreover, it tries to see if the
responsible are given sufficient power and scope to do what is required.
g) Organizational – the appraisal examines the project if it is organized internally and externally
into units, contract policy institution, etc so as to allow the proposals to be carried out properly
and to allow for change as the project develops.
These issues are the subjects of specialized appraisal report. And on the basis of this report,
financial decisions are made – whether to go ahead with the project or not. In practice, there can
be quite a sequence of project selection decisions. Following appraisal, some projects may be
discarded. If the project involves loan finance, the lender will almost certainly wish to carry out
his own appraisal before completing negotiations with the borrower. Comments made at the
appraisal stage frequently give rise to alterations in the project plan (project proposal).
4. Implementation
The objective of any effort in project planning and analysis clearly is to have a project that can
be implemented to the benefit of the society. Thus, implementation is perhaps the most important
part of the project cycle.
In this stage, funds are actually disbursed to get the project started and keep running. A major
priority during this stage is to ensure that the project is carried out in the way and within the
period that was planned. Problems frequently occur when the economic and financial
environment at implementation differs from the situation expected during appraisal. Frequently
original proposals are modified, though usually only with difficulty, because of the need to get
agreement between the parties involved.
It is during implementation that many of the real problems of projects are first identified.
Because of this, the feedback effect on the discovery and design of new projects and the
deficiencies in the capabilities of the project actor can be revealed.
Therefore, to allow the management to become aware of the difficulties that might arise,
recording, monitoring and progress reporting are important activities during the

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implementation stage. There are some aspects of implementation that are of particular relevance
to project planning and analysis.
a. The first is that the better and more realistic a project plan is, the more likely it is that plan
can be carried out and the expected benefit realized. This emphasizes once again the need
for careful attention to each aspect of project planning and analysis.
b. The second is that project implementation must be flexible. Circumstances will change and
project managers must be able to respond intelligently to these changes. The common ones
are technical changes (soils, water logging, and nitrogen application) price changes
economic changes, political changes and these will alter the ways in which it should be
implemented.

5. Evaluation
The final phase in the project cycle is evaluation. Once a project has been carried out, it is often
useful, (though not always done) to look back over what took place, to compare actual progress
with the plans, and to judge whether the decisions and actions taken were responsible and useful.
The extent to which the objectives of a project are being realized provides the primary criterion
for an evaluation. The analyst looks systematically at the elements of success and failure in the
project experience to learn how better to plan for the future.

Many different people may do evaluation.

- Project management will be continuously evaluating its experience as implementation
proceeds.

- The sponsoring agency, perhaps the operating ministry, the planning agency or an external
assistance agency – may undertake evaluation.
- In large and innovative projects, the project’s administrative structure may provide a separate
evaluation unit responsible for monitoring the projects implementation and for bringing
problems to the attention of the projects’ management.

Evaluation can help not only in the management of the project after the initial phase, but will
also help in the planning of future projects. Experience with one project can give rise to new
ideas for extension of the project, repetition, the need for “vertically” associated projects, which

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supply, inputs to or process products from this project, and other ideas which become the seeds
or new project proposals.

B) DEPSA’s Project Cycle

There are various ways in which the project cycle may be viewed and portrayed depending on
the purpose, emphasis and detail required to illustrate. According to the Guidelines to project
planning in Ethiopia (1990) of Development Project Studies Authority (DEPSA), the project
cycle comprises three major phases.
1. Pre – investment

2. Investment and

3. Operation

Each of these three phases may be divided into stages. The Guidelines has divided the Project cycle
into six stages

1. Identification

2. Preparation

3. Appraisal/decision

4. Implementation

5. Operation

6. Ex-post evaluation

The pre – investment phase consists of the first–three stages, the investment phase includes the
fourth stage and the operation phase covers the last two stages. In reality, these are somewhat
artificial, but do serve to emphasis the need to think of project planning as a process of decision-
making taking place over time. Broadly speaking, what is important about this process is that it
should begin with the identification of a number of alternatives, using existing information and
gathering new data in such a way as to limit alternatives under consideration to those few, which
are most promising. Throughout the project cycle the primary preoccupation of the analyst is to
consider alternatives, evaluate them, and to make decisions as to which of them should be
advanced to the next stage. In short, the project planning process is essentially one of eliminating
and the planner naturally hopes that the best alternative will emerge.

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In this process:
I. The results (output) of a given stage serve as the input or part of the input of the next stage, if it
is decided to proceed to the next stage.

II. The output or part of the output of one stage may be used as new input (feedback) to
reconsider or revise, where necessary, the result of a proceeding stages and

III. Most importantly, the results of the implementation, operation and ex-post evaluation stages
of a project constitute valuable experience for the preparation of subsequent projects provided
these inputs are systematically documented and analyzed.

C) UNIDO – Project Cycle

UNIDO has established a project cycle comprising three distinct phases:
 The pre investment phase,

 Investment phase and

 Operational phase phases.

The pre- investment phase comprises:

 project identification,

 project preparation and

 Appraisal of project studies

The investment phase constitutes negotiation and contracting, engineering design, construction
and preproduction marketing. And the operational phase includes commissioning and starts up of
production, replacement and rehabilitation, and expansion and innovation.
1. THE PRE INVESTMENT PHASE

The pre investment phase comprises several stages: identification of investment opportunities
(opportunity studies), project preparation (pre-feasibility and feasibility studies) and project
appraisal (preparation project investment decisions report).
i. Project Identification
Project identification amounts to finding projects which could contribute towards achieving
specified development objectives. In principle, especially in developing countries like Ethiopia,

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project identification should be an integral part of the macro-planning exercise with sectorial
information and strategies as the main source of project ideas. In practice, however, projects are
not always derived from national and sectorial plans; they originate from multiple sources such
as investment promotion agencies, private consultants and private investors. Irrespective of their
origin project ideas should, in general, aim at: overcoming constraints to the development effort,
be they material, human or institutional constraints; or, meeting unsatisfied needs and demand
for goods and services. Constraints, needs and demand should be interpreted broadly to include,
for example, foreign exchange constraints that might necessitate projects for import substitution
or export promotion.
a) Opportunity studies:
The identification of investment opportunities is the starting – point in a series of investment –
related activities, when potential investors (private or public) are interested in obtaining
information on newly identified viable investment opportunities.
Where does Projects Originate? The variety of projects makes it impossible to prepare an exhaustive
list of sources from where project ideas emanate; much depends on the experience, and even
imagination, of those entrusted with project creation. In general, we can distinguish two levels where
project ideas are born: the macro-level and the micro-level.
At the macro-level, project ideas emerge from:
i. National, sectorial, or regional plans and strategies supplemented by special studies, often called
opportunity studies, conducted with the explicit aim of translating national and sectorial programs
into specific projects;
ii. constraints in the development process due to shortages of essential infrastructure facilities,
problems in the balance of payments, etc.;

iii. A government’s decision to correct social and regional inequalities or to satisfy basic needs of the
people through development projects;

iv. A possible external threat that necessitates projects aiming at achieving, for example, self-
sufficiency in basic materials, energy, transportation, etc.;

v. Unusual events such as droughts, floods, earth-quakes, hostilities, etc.; and

vi. A government’s decision to create locally project implementing capacity in such areas as
construction etc.

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 Vii. Can also originate from multilateral or bilateral development agencies and as a result of
regional or international agreements in which a country participates.

At the micro-level, project ideas emanate from:

I. The identification of unsatisfied demand or needs

II. The existence of unused or underutilized natural or human resources and the perception of
opportunities for their efficient use

III. The need to remove shortages in essential materials, services or facilities that constrain the
development effort

IV. The initiative of private or public enterprises in response to incentives provided by the
government

V. The necessity to complement or expand investments previously undertake

VI. The desire of local groups or organizations to enhance their economic independence and
improve their welfare.

b) Preliminary Screening: Once some project ideas have been put forward, the first step is to
select one or more of them as potentially viable. This calls for a quick preliminary screening by
experienced professionals who could also modify some of the proposals. At this stage the
screening criteria are vague and rough, becoming specific and refined as project planning
advances. During preliminary selection the analyst should eliminate project proposals that are
technically unsound and risky; have no market for the output; have inadequate supply of inputs;
are very costly in relation to benefits; assume overambitious sales and profitability; etc.

Obviously, since the criteria are imprecise much depends on the experience and impartiality of
the professionals applying them. It is, however, necessary to conduct this screening, even with
indistinct criteria, in order to reduce to a manageable number the project alternatives to which
more work and time will be devoted. After all, project planning is a process of elimination, i.e.
elimination of inferior alternatives.

c) Pre-feasibility Studies: Following the preliminary screening, promising project options should
be investigated in a systematic manner. This requires the preparation of brief reports that indicate
in sufficient, but not painstaking, detail the project versions that are still promising and suggest

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which ones should be eliminated. Sophisticated analysis, of the technical, financial, economic
social and institutional aspects of the project are postponed to a later stage before assigning
larger funds for such a study, since feasibility studies are costly and time-consuming.

However, the reports should indicate which of these aspects deserve particular attention during
the subsequent step. Reports of this type are often called pre-feasibility or pre-investment. A pre
– feasibility study should be viewed as an intermediate stage between a project opportunity study
and a detailed feasibility study, the difference being in the degree of detail of the information
obtained and the intensity with which project alternative are discussed. The structure of a pre –
feasibility study should be the same as that of a detailed feasibility study.

Content of the Pre-feasibility Study: To enable the relevant authorities to decide on the merits
of various project options, the pre-feasibility study should, although briefly, discuss:
i. The structure and objectives of the project;

ii. The nature and size of the demand for the output or the needs that it would satisfy, together
with the foreseen beneficiary groups;

iii. The availability of the most important materials and human inputs;

iv. Basic alternative technologies available and their merits and weaknesses;

v. Approximate investment and operation costs as well as expected revenues and other benefits;

vi. Rough estimates of financial and economic returns;

vii. Any major factor that is likely to have an important effect on the project; and

viii. What further information on the technical, financial, economic or institutional aspects of the
project should be acquired through special studies and surveys?

By the end of the identification stage we should know:

a) Whether further detailed work is justified;

b) What major issues have been identified, what project alternatives have been considered and
which of them have been rejected; and

c) A rough estimate of costs.

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For projects that still look promising, a specific work plan for the next stage should also be
included in the study.

ii. Project Preparation – Feasibility Studies

A feasibility study should provide all data necessary for an investment decision. The
commercial, technical, financial, economic and environment prerequisites for an investment
project should therefore be defined and critically examined on the basis of alternative solutions
already reviewed in the pre – feasibility study.
If the pre-feasibility study indicates that the project is, prima facie, promising and further work is
justified, the project enters the stage of preparation. The project, already defined in a sketchy
form, is now being advanced to a level at which it can be appraised thoroughly before a decision
is taken on whether to implement it. The analysis of the project’s marketing, technical, financial,
economic and institutional aspects should be comprehensive enough to allow the policy makers
to decide on the future of the project with confidence. Project preparation takes the form of a
feasibility study conducted by the agency sponsoring the project or by consultants. At this point
it would be helpful to address a question often raised, i.e. what is the difference between a pre-
feasibility and a feasibility study? The answer is simple: they differ only with respect to the
amount of work needed to decide if a project is viable. The table of contents is the same in both;
it is the details and the sophistication that vary.

How Much Preparation: At this point we can ask how far in detail should project preparation
advance before the project is ready for appraisal. This is a practical question and the answer
depends upon the magnitude and the characteristics of the project. Projects that commit relatively
small amounts of investment funds do not deserve painstaking and expensive preparation. After
all, the risks taken in implementing small projects are small; of course, what is small is a
practical question. Furthermore, projects that: (i) consist of a large number of small, dispersed
components (e.g. hundreds of primary schools or village water supplies) or, (ii) depend heavily
on community participation, need not be prepared in detail before an investment decision is
made.

Often, those responsible for project planning complain that too much information is asked from
them and that they have to spend unnecessarily long time in project preparation. In most cases

19
their complaints are not justified. They should realize that resources are scarce and mistakes
expensive. Furthermore, time spent on project preparation is not lost time. There is a trade-off
between project preparation and implementation. The better a project is prepared the easier and
faster its implementation and the lower the probability of cost overruns.
The need for professional project preparation does not imply that this stage should include
engineering design that precedes implementation and which provides more accurate cost
estimates. However, it is essential that the project is prepared to a level that its characteristics are
clearly presented, its objectives and beneficiaries accurately defined and its merits and
shortcomings thoroughly discussed. It is only on such a sound base that apprized judgment can
be formed by the authorities responsible for investment decisions. Obviously, when it is expected
that the project will be financed entirely or partly by multilateral or bilateral aid agencies, their
specific requirements and standards of project preparation should be taken into account.
Before proceeding to the stage of project appraisal we should mention that pre-feasibility and
feasibility studies become much easier to conduct when precise and comprehensive terms of
reference are prepared for these studies. Issued to a working group of local experts or to outside
consultants, the terms of reference should make clear that the project should be researched
carefully and all its aspects illuminated. Those responsible for planning the project should be
asked to provide, as a minimum, in their report the information mentioned in these Guidelines
and to follow the methodology adopted here.

iii. Appraisal and Investment Decision

Up to the completion of preparation, the project has been nursed by the sponsoring agency; now
it changes hands. The project proposal in the form of a feasibility study is submitted to the
investment decision makers for a broad and impartial appraisal. Appraisal is the comprehensive
and systematic assessment of all aspects of the proposed project. After appraising the project
carefully, appraisers will decide whether it will be implemented or not, with or without minor
modifications.
Criteria: At the early stages of the project cycle we might say that the evaluation criteria are
mainly, but not exclusively, technical and micro-economic in character. It is at this stage, and
before an investment commitment is made, that the project should be reviewed again to confirm
that it accords with the broad development objectives, or criteria set by donors, or bankers or

20
other parties who have a stake in the project. The framework within which the project is
appraised is broad and multi-faceted.
An investment decision should be based on careful consideration of macro-development and
project perspectives to ensure that the project represents a high-priority use of the investors’
resources. During appraisal, it should be verified that the project, in combination with other
policies, contributes the maximum possible towards achieving certain development objectives.
How smoothly the appraisal will proceed depends on how well the project has been prepared.
Appraisal Perspectives: Considered always within the broad development framework, the
project, during appraisal, is viewed from different perspectives. All the technical, commercial,
economic, environmental, social, organizational and incentive aspects should be considered.
2. THE INVESTMENT PHASE
The next stage in the project is the actual implementation of the project, followed by operation.
Implementation begins immediately after the final decision on the project ends when it starts
rendering the benefits envisaged. While in earlier stages of project planning there was more
thinking and less action, in this stage the combination switches in favor of the latter: more action
and less thinking is needed. It is the time when the conclusions reached and the decisions made
are put into action. Detailed engineering design comprises preparatory work for site preparation,
the final selection of construction planning and time – scheduling of factory construction, as well
as the preparation of flow charts, scale drawing and a wide variety of layouts.
During the stage of tendering and evaluation of bids it is especially important to receive
comprehensive tenders for goods and services for the project from a sufficiently large number of
national and international supplies of proven efficiency and with good delivery capacity.
Negotiations and contracting are concerned with the legal obligations arising from the
acquisition of technology the construction of buildings, the purchase and installation of
machinery and equipment and financing. This stage covers the signing of contracts between the
investor or entrepreneur, on the one hand, and the financing institutions, consultants, architects
and suppliers of raw materials and required inputs, on the other.
The construction stage involves site preparation, construction of buildings and other civil works,
together with the erection and installation of equipment in accordance with proper programming
and scheduling.

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The personnel recruitment and training stage, which should proceed simultaneously with the
construction stage, may prove very crucial for the expected growth of productivity and efficiency
in plant operations.
Of particular relevance is the timely initiation of marketing arrangements to prepare the market
for the new products (pre – production marketing) and secure critical supplies (supply
marketing).

In general, it is to be noted that in the pre – investment phase, the quality and dependability of
the project are more important than the time factor, while in the investment phase, the time factor
is more critical in order to keep the project within the forecast made in the feasibility study.

The phase is divided into the following stages:

1) Establishing the legal, financial and organizational basis for the implementation of the
project.

2) Technology acquisition and transfer, including basic engineering.

3) Detailed engineering design and contracting, including tendering, evaluation of bids and
negotiations. Detailed engineering design will include site preparation final selection of
technology construction planning and time scheduling as well as flow charts and scale
drawings preparation. Negotiations are concerned with legal obligations arising from the
acquisition of technology, construction of buildings, purchase and installation of machinery,
and financing

4) Acquisition of land construction work and installation. This involves site preparation
construction of buildings and other civil works, together with erection and installation of
equipment

5) Pre-production marketing, including the securing of supplies and setting up of the

administration of the firm. This and secures critical supplies prepares the market for the new
product

6) Recruitment and training of personnel. This stage proceeds simultaneously with the
construction stage to ensure timely commissioning and the expected growth in productivity
and efficiency in plant operations.

The need to pay particular attention to project implementation cannot be overemphasized. No

matter how carefully a project has been prepared and evaluated, the expected benefits are
realized only when it is properly implemented; it is not project reports but studiously executed

22
projects that deliver the envisaged benefits. Of course, it is easier to execute a well prepared
project but sound preparation is not a substitute for careful programming and close control
during implementation. This is all the more so because most projects face problems during
implementation and some of them can not be identified in advance; they emerge as we proceed
in the execution of the project. Some implementation problems are the result of general factors
such as changes in the economic and political situation of the country or the world market while
others are project specific.

3) OPERATIONAL PHASE

This is the production phase that commences after commissioning and start-up. The resultant
challenges of this phase are viewed from the short-term perspective and long-term perspective.
In the shot-term challenges may arise with regard to application of production techniques
operation of equipment, inadequate labor productivity due to a lack of qualified staff and labor
etc. Most of these problems have their origin in the implementation phase.

The long- term view relate to the chosen strategies and the associated production and marketing
costs as well as sales revenues. These have a direct relationship on the projections made during
the pre-investment phase. If such strategies and projection prove faulty any remedial measure
will not only prove difficult but may be too expensive.

Chapter Two
Project Identification and Preliminary Studies

2.1 Project Idea- Meaning

Project idea identification is the first step towards establishing a successful venture. This stage is
about finding potential projects that will result in positive net present value or that provide benefits
for the society. This is the starting stage in the project cycle. Projects usually start as new ideas which
are carefully examined and if found feasible and desirable are translated in to projects. Such initiation
of project ideas is called project conception. Project conception is forming or developing ideas
regarding a required intervention in a specific area to address a problem or take advantage of
opportunities. Identification of project idea requires imagination, sensitivity to environmental

23
changes and realistic assessment of what the firm can do. Theoretically an investor has an infinitely
wide choice with respect to investment opportunities.

Project identification is interrelated with the government policies, infrastructural developments and
skill of people. Project identification is concerned with collection, compilation and analysis of
economic data for the purpose of locating possible opportunities for investment and with
development of such opportunities.

N.B:- For sources of project idea please refer the “Project Life Cycle” in the first chapter.

Who can initiate project ideas?

1. Technical specialists
Technical specialists can initiate project ideas from their experiences of through their research
findings. This usually is common in manufacturing firms where mechanical and industrial engineers
working there generate new expansion and/or new industrial projects. These projects usually either
improve the products being produced currently or produce new products.
2. Local leaders
Social and community projects could emanate from the suggestions made by local leaders regarding
the problems prevailing in the area. Local leaders could also initiate project ideas from already
identified or implemented projects. For instance, project ideas on irrigation could be initiated from an
already constructed hydro-electric dam.
3. Entrepreneurs
Entrepreneurship includes the characteristics of perception of managerial competence and motivation
to achieve results. These characteristics make entrepreneurs the major sources of industrial and
commercial projects. Although entrepreneurship skills have been passed on from one generation to
another along family and socio-economic circles, it has been recognized that programs for
entrepreneurship development will help individuals to come up with useful ideas.
4. Governments
Government guidelines such as national development plans that spell out what the government is
likely to do to achieve its targets in different sectors of the economy are the sources of many projects
by the government and entrepreneurs.

Tips to find good project ideas

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Identifying good project ideas that can be translated to viable projects requires looking in to a wide
variety of sources. Some of the sources to look in to in finding good project ideas include:

A) Analyzing the performance of the existing industries

Analyzing the exiting firms in an industry in terms of their profitability and capacity utilization can
indicate of promising investment opportunities. Analysis of the capacity utilization of the existing
firms can be used to assess the possibilities for further investment. Such studies become more useful
if they are made region wise, particularly for products with high transportation costs. This makes the
analysis more dependable because the chance that the product will be supplied from distant areas is
minimal.

B) Examine the inputs and outputs of existing industries

Analysis of the inputs being used by existing industries could be sources of project ideas relating to
supplying these inputs. Profitable opportunities exist when:
 Materials and parts are being supplied from distant areas with lags and high transportation costs
 Several firms are internally producing some components which can be supplied at a lower cost
by a single manufacturer which can employ economies of scale.

Analysis of the out puts of firms will provide project ideas on further processing of the products. In
addition, the analysis of out puts can throw up ideas on utilization of wastes products and byproducts.
Production of ethanol from the byproduct of sugar factories is a good example in this case.
C) Review of imports and exports
Review of the imports of a country over the years provides possibilities of import substitution. Such
projects have numerous benefits for the country in terms employment creation, forward and back
ward linkages, and improving balance of payments. Analysis of exports presents the export
possibilities. Many of the plastic factories in our country could be mentioned in this instance.

D) Government plans and guidelines

The national development plan of a country is good indicator of a government’s likely expenditures
in the future. Hence, careful review of the government’s national and sectoral development plans and
strategies can identify profitable projects with an added advantage of facilitating a country’s
development goals.

E) Investigation of local resources and skills

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A search for project ideas may start with the analysis of the local resources and skills. Then projects
that can profitably utilize the skill and resources will be designed. The weaving skills of those
making traditional clothes could be a source of project idea if one plans to use the skill for mass
production of the clothes.

F) Analyze social and economic trends

Future demand for a good or a service is hugely affected by the social and economic changes of a
society. Therefore, close investigation of the economic trends and social changes on consumption
patterns provide many business opportunities. The changes in the settlement and working pattern of
Addis residents somehow have resulted in trash collection services.

G) Drawing clues from consumptions abroad

Entrepreneurs may identify projects for the production of products or supply of services which are
new to the country but extensively used abroad. Packed water production by Apex bottling and other
manufactures can be taken as an example here.
2.1 Opportunity Studies and Preliminary Screening
From macro and micro sources mentioned in the first chapter a long list of project ideas can be
developed. However, those projects that are not promising should be eliminated through a screening
process. This preliminary screening weighs a project in terms of the following variables

o Compatibility with the Promoter

The idea should be compatible with the interest, personality and resources of the entrepreneur. A real
opportunity should fit the personality of the promoter-abilities, training and priorities; accessible and
offers a prospect of rapid growth and high return on invested capital.
o Compatible with Governmental Priorities
The project idea should be within the government’s regulatory framework. In addition, it should be in
line with the country’s goals to ensure its sustainability.
o Availability of Inputs
The resources and inputs required for the project must be reasonably assured. These inputs include:
capital requirements of the project, technical know-how, raw materials, power and foreign exchange.
o Adequacy of Markets
The size of the market for the goods or services produced by the project must offer adequate sales
volume. In this regard, both the current and predicted demand levels should be assessed. In general
assessment of the market adequacy should consider:

26
 Total present domestic market
 Competitors and their market share
 Export markets
 Sales and distribution system
 Projected increase in consumption
 Barriers to entry
 Economic, social and demographic trends
 Patent protection
o Reasonableness of Costs
The cost of the proposed project should be commendable considering the benefits expected from it.
The following costs are considered in this regard:
 Cost of material inputs and labor
 Factory overheads
 Administrative expenses
 Service costs and
 Economies of scale
o Acceptability of Risk Level

The desirability of a project is critically dependent on the risk characterizing it. The following factors
are used in assessing the risk level of a project:
 Vulnerability of business cycle
 Technological changes
 Competition from substitutes and imports
 Government control over price and distributions
2.2 Pre-feasibility Studies
Since formulation of the feasibility study is costly and time consuming task, further assessment of the
project idea is made in a pre-feasibility study. It is an intermediate stage between the project
identification and a detailed feasibility study. The principal objectives of it are to determine:
 All possible project alternatives are examined
 The project concept justifies a detailed analysis of a feasibility study
 The project idea on the basis of available information should be considered either non-viable or
attractive enough

27
 The environmental situation at the planned site and the potential impact of the projected
production process are in line with national standards.
The difference between the feasibility study and the pre-feasibility study is in the extent of detail of
the information obtained. The structure of the pre-feasibility study should be the same as the
structure of the feasibility study. However, detailed review of the available alternatives must take
place at this stage since it is costly and time consuming to do this in the feasibility stage. In
particular, the review should cover the various alternatives identified in terms of:
 Project or corporate strategies and scope of the project

 Market and marketing concept

 Raw materials and factory supplies

 Location, site and environment

 Engineering and technology

 Organization and overhead costs

 Human resource

 Project implementation schedule and budgeting

In general, the pre-feasibility study involves subjective judgment of the project in terms of:
Availability of an adequate market: - judgments relating to the number of potential customers,
needs of the customers, strength of the competitors, availability and access to sales and distribution
network and export possibilities.
Project growth potential: - assessment of indicators on projected increase in the number of
customers, increase in the rate of acceptance of the products, the general economic, social and
political trend which could affect the growth potential of the project.
Investment costs: - Costs of raw materials transportation costs, distribution costs, labor costs,
production costs and investment costs are usually considered. If the above costs are very high
sustainability of the project is questionable.
Demand and supply factors: - This involves the projection of both short term and long term
requirements of the project’s output and examining the implications of these on the project’s
capacity. Many projects fail because they have started with a very large capacity only to operate at a
much lower capacity. On the other hand, increasing the capacity of the project shortly after it starts
operation is very costly.

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Social and environmental considerations: - the project should also conform to the social
considerations of the locality in which it is implemented. In addition; especially in industrial projects,
due consideration should be given to the environmental effects of it on the surrounding.

Chapter Three
Project Preparation
A project preparation (feasibility studies) is detailed analysis of the project in different
dimensions that lead to an investment decision. It provides information required for the project
appraisal. It usually includes market analysis, technical analysis, environmental analysis
(environmental impact assessment), financial analysis, socio-economic analysis and sensitivity
analysis among others.

3.1 Market and Demand Analysis

In most cases, the first step in project analysis is to estimate the potential size of the market
proposed for to be manufactured. To put it differently, market and demand analysis is concerned
with two broad issues; what is the likely aggregate demand for the product? What share of the
market will the project enjoy?

Given the importance of market and demand analysis, it should be carried out in an orderly and
systematic manner. The key steps in such analysis are as follows:
- Situational analysis and specification of objectives
- Collection of secondary information
- Conduct market survey
- Characterization of the market
- Demand forecasting
3.1.1 SITUATIONAL ANALYSIS AND SPECIFICATION OF OBJECTIVES
In order to get a 'feel' for the relationship between the product and its market, the project analyst
may informally talk to customer competitors, middlemen, and others in the industry. Wherever
possible, he may look at the experiences of the company to learn about the preferences and
punishing power of customers, actions and strategies of competitors.

To illustrate, suppose that a small but technological competent firm has developed an air cooler
based on a new principle that appears to offer several advantage over the conventional (former)

29
air cooler. The chief executive of the firm needs information about where and how to market the
new air cooler. The objectives of market and demand analysis in this case may be to answer the
following questions:

- Who are the buyers of air cooler?

- What is the total current demand for air cooler?
- How is the demand temporarily distributed (pattern of sales over the year) and
geographically?
- What is the break-up of demand for air coolers of different size?
- What prices will the customers be willing to pay for the improved air cooler?
- How can potential customers be convinced about the superiority of the new cooler?
- What price and warranty will ensure its acceptance?
- What channel of distribution is most suited for the air cooler? What trade margin will
induce distributors to carry it?
- What are the prospects of immediate sales?
3.1.2 COLLECTION OF SECONDARY INFORMATION
In order to answer the questions listed while delineating the objective of the market study,
information may be obtained from secondary and/or primary sources. Secondary information is
information that has been gathered in some other context and is already available. Primary
information, on the other hand, represents information which is collected for the first time to
meet the specific purpose on hand. Secondary information provides the base and the starting
point for market and demand analysis. It indicates what is known and often provides leads and
cues for gathering primary information required for further analysis.

The important sources of secondary information useful for market and demand analysis in
Ethiopia are for example census of Ethiopia, national sample survey reports, statistical abstracts,
annual survey of industries/agriculture and export, economic survey, annual report by national
bank of Ethiopia, bulletin on import and export and the like are some of them.

3.1.3 CONDUCT OF MARKET SURVEY

For undertaking a market survey there is a need to have a sample, which represents the entire
market. Thus, sampling is the process of drawing a limited number of subjects from a larger

30
population or universe. Since, the researcher cannot survey the entire universe or population that
they are interested, they usually draw a sample of subjects from the population for investigation.

Steps in a Sample Survey

Typically a sample survey consists of the following steps:
1. Define the target population: in defining the target population the important terms
should be carefully and unambiguously defined.
2. Select the sampling scheme and sample size: there are several sampling schemes, simple
random sampling, cluster sampling, sequential sampling, stratified sampling, systematic
sampling and non-probability sampling. Each scheme has its advantage and limitations.
The sample size, other things being equal, has a bearing on the reliability of the estimates
– the larger the sample the greater reliability.
3. Develop the questionnaire: the questionnaire is the principal instrument for eliciting
information from the sample of the respondent. Since the quality of the questionnaire has
an important bearing on the results of market survey, the questionnaire should be tried
out in a pilot survey and modified in the light of problems/ difficulties noted.
4. Recruit and Train the Field Investigators: recruiting and training of field investigators
must be planned well since it can be time consuming. Great care must be taken for
recruiting the right kind of investigators and imparting the proper kind of training to
them.
5. Obtain information as per the questionnaire from the sample respondent
6. Scrutinize the information gathered: information gathered should be thoroughly
scrutinized to eliminate data which is internally inconsistent and which is of dubious
validity.
7. Analyze and Interpret the Information: information gathered in the survey need to be
analyzed and interpreted with care and imagination. After tabulating it as per a plan of
analysis, suitable statistical investigation may be conducted, wherever possible and
necessary. Results of data based on sample survey will have to be extrapolated to the
target population.
3.1.4 CHARACTERISTICS OF THE MARKET

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Based on the information gathered from secondary sources and through the market survey, the
market for the product may be described in terms of effective demand in the past and present,
breakdown of demand, price, methods of distribution and sales promotion, consumers, supply
and competition and government policy.

3.1.5 DEMAND FORECASTING

After gathering information about various aspects of the market and demand from primary and
secondary sources, an attempt may be made to estimate future demand. A wide range of
forecasting method is available to the market analyst. This may be broadly divided into
qualitative, quantitative and mixed methods.
3.2 Technical Analysis
Analysis of technical and engineering aspect is done continually when a project is being
examined and formulated. Other types of analysis are dependent and closely intertwined with
technical analysis. Technical analysis is concerned primarily with:
- material inputs and utilities
- manufacturing process/technology
- product mix
- plan capacity
- location and site
- machineries and equipments
- structures and civil works
3.2.1 MATERIAL INPUTS AND UTILITIES
An important aspect of technical analysis is concerned with defining the materials and utilities
required, specifying their properties in some detail and setting up their supply programme.
Material inputs and utilities may be classified into four broad categories: 1. Raw Materials, 2.
Processed Industrial Materials and Components, 3. Auxiliary Materials and Factory Supplies,
and 4. Utilities.
1. Raw Materials
Raw materials (processed and/or semi processed) are those materials which can be taken as an
input to product an output. Raw material could be: agricultural products, mineral products,
livestock and forest products, and marine products.

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2. Processed Industrial Materials and Components
Processed industrial materials and components (base metal, semi-processed materials,
manufactured parts, components and sub assemblies) represents important input for a number of
industries. In studying them, the following questions needs to be answered. In the case of
industrials materials; what are their properties? What is the total requirement of the project?
What quantity would be available from domestic sources? What quantity would be procured
from foreign sources? How dependable the supplies are? What has been the past trend in price/
what is the likely future behavior of price?
3. Auxiliary Materials and Factory Supplies
In addition to the basic raw materials and processed industrial materials and components, a
manufacturing project requires various auxiliary materials and factory supplies like chemicals,
additives, packaging materials, paints, varnishes, oil, greasing, cleaning materials, etc. The
requirement of such auxiliary material should be taken into account in the feasibility study.
4. Utilities
A broad assessment of utilities (power, water, steam, fuel, etc) may be made at the time of input
study though a detailed assessment can be made only after formulating the project with respect to
location, technology, and plant capacity.
5.2.2 MANUFACTURING PROCESS/TECHNOLOGY

It is to be ensured that the manufacturing process to be adopted is modern and at the same time
appropriate to the level of economic development of the country. Where sophisticated or new
process is to be adopted, the advice of a committee of technical experts is also sought before the
project is cleared.

Normally the choice of technology is influenced by a variety of consideration like plant

capacity, principal Inputs, investment outlay and production cost, use by other units, latest
development, and ease of absorption.

Another issues related with technology is: acquiring technology, and appropriateness of
technology. The company can acquire technology by way of technology licensing, outright
purchases, or joint ventures arrangement

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Appropriateness of Technology
Appropriate technology refers to those methods of production which are suitable to local
economic, social and cultural conditions. These who basically advocate the appropriateness of
technology urge that the technology should be evaluated in terms of the following questions:

 Whether the technology utilizes local raw materials?

 Whether the technology utilizes local manpower?
 Whether the goods and services produced cater to the basic needs?
 Whether the technology protects the ecological balance?
 Whether the technology is harmonious with social and cultural conditions?
3.2.3 PRODUCT MIX
The choice of product mix is guided by market requirements. In the production of most of the
items, variation in size and quality are aimed at satisfying a broad range of customers. For
example, a garment manufacturer may have a wide range of choices in terms of size and quality
to cater to different customers. It may be noted that the variation in quality can enable a company
to expand its market and enjoy higher profitability. Hence, product mix as an element of
technical analysis has to be done well in light of the needs and wants of customers.

3.2.4 PLANT CAPACITY

Plant capacity (also referred to as production capacity) refers to the volume or number of units
that can be manufactured during a given period. Several factors have a bearing on the time
capacity decision.
a. Technological requirements: for many industrial projects, particularly in process type
industries, there is a certain minimum economic size determined by the technological
factor. For example, a cement plant should have expected to produce a capacity of at least
300 tons per day; otherwise it may not be cost effective and the like.
b. Input constraints: in a developing country like Ethiopia, there may be constraints on the
availability of certain inputs. Power supply may be limited, basic raw materials may be
scarce, foreign exchange available for import may be inadequate. Constraints of these
kinds should be borne in mind while choosing the plant capacity.
c. Market conditions: the anticipated market for the product has an important bearing on
plant capacity. If the market for the product is likely to be very strong, a plant of higher

34
 capacity is preferable. If the market is likely to be uncertain, it might be advantageous to
start with a smaller capacity.
d. Resource of the firm: the resource, managerial and financial, available to a firm define a
limit on its capacity decision; obviously, a firm cannot choose a scale of operations
beyond its financial resources and managerial capacity.
e. Government policy: the capacity level may also be influenced by government policy.
3.2.5 LOCATIONS AND SITE

The choice of location and site follows an assessment of demand, size, and input requirement.
Though often used synonymously, the term ‘location’ and ‘site’ should be distinguished.
Location refers to a fairly broad area like a city, an industrial zone, or a coastal area; while site
refers to a specific piece of land where the project would be set up.
The choices of location are influenced by a variety of considerations: proximity to raw materials
and market, availability of infrastructure, government policy and other factor.

Proximity to Raw Materials and Markets

An important consideration for location is the proximity to sources of raw material and nearness
to the market for final products. This generally implies a resource based project like cement plant
should be located close to the sources of raw material, a projected based on imported material
may be located near a port, and a project manufacturing a perishable product should be close to
the center of consumption.

Availability of Infrastructure
Availability of power, transportation, water and communication should be carefully assessed
before a location decision is made. Adequate supply of power is a very important condition for
location; insufficient power can be major constraints, particularly in the case of an electricity
intensive project like an aluminum plant.

Governmental Policies
Government policies have a bearing on locations. In the case of public sector project, location is
directly decided by the government. It may be based on a wider policy for regional depression of
industries. In the case of private sector projects, location is influenced by certain governmental

35
restrictions and inducements. The government may prohibit the setting up of industrial projects
in certain areas which suffer from urban congestion. More specifically the government offers
inducements for establishing industries in backward areas. This inducement consists of subsidies,
concessional loan (i.e., loan at a lower interest rate), tax relief and other benefits.

Other Factors
Several other factors have to be assessed before reaching a location decision: ease of coping with
environmental pollution, labor situation, climatic conditions and general living condition.

Site Selection
Once the broad location is chosen, attentions need to be focused on the selection of a specific
site. Two to three alternative sites must be considered and evaluated with respect to cost of land
and cost of site preparation and development. The cost of land tends to differ from one site to
another in the same broad location. Sites close to a city cost more whereas sites away from cities
cost less.
3.2.6 MACHINERIES AND EQUIPMENTS
The requirements of machineries and equipments are dependent on production technology and
plant capacity. It is also influenced by a type of project. In addition to the machineries
equipment, a list should be prepared of spare parts and tools required.
3.2.7 STRUCTURE AND CIVIL WORKS
Structures and civil works may be divided into three categories
- Site development and preparation
- Building and structure
- Outdoor works
Site Development and Preparation
This cover the following
1. Grading and labeling of the site
2. Demolition and removal of existing structures
3. Relocation of existing pipelines, cables, roads etc
4. Reclamation of swamps and draining and removal of standing water

36
 5. Connections for the following utilities from the site to the public networks; electric
power, water for drinking and other purpose, communication (telephone, telex, fax
internet etc.

Building and Structure

Building and structure may be divided into
1. Factory or process building
2. Ancillary building required for stores, laboratories, utility supply centers, maintenance
service and others
3. Administrative building
4. Staff welfare building, cafeteria, medical service center etc
5. Residential building

Outdoor Works
Outdoor works covers
1. Supply and distribution of utilities
2. Handling and treatment of emissions, wastages and effluents
3. Transportation and traffic arrangements
4. Outdoor lighting
5. Landscaping
6. Enclosure and supervision (boundary wall, fencing, barriers, gates, doors, security pots
etc.)

3.3 Environmental Impact Assessment

Environmental Assessment (EA) is a process whose breadth, depth and type of analysis depend on
the nature, scale and potential environmental impact of the proposed project. EA evaluate a project's
potential environmental risks and impacts in its area of influence, examine project alternatives,
identities ways of improving selection, siting, planning, design and implementation by preventing,
minimizing, mitigating or compensating for adverse environmental impacts and enhancing positive
impacts and includes the process of managing adverse environmental impacts throughout project
implementation.

37
Public and government awareness of the negative impact of development on the environment has
increased over the last thirty years in developed and developing countries. The first move to assess
the environmental impact from development projects originated in the USA in the seventies. This led
to the development of environmental impact assessment (EIA) methods, which have been
increasingly adapted and adopted by many other countries.

Concern for environmental degradation in Ethiopia has been growing in recent years. The Ethiopian
Federal Democratic Republic Constitution provides the basic and comprehensive principles and
guidelines for environmental protection and management. The government is currently developing
the institutional and policy framework for the implementation of environmental assessment in the
country. The constitution states that everyone has the right to live in a clean and healthy environment
and the government will make every effort to provide such an environment. The constitution also
holds the government and the people of Ethiopia responsible for the preservation of natural resources
and maintenance of ecological balances. The three most urgent areas of environmental concerns are:

1. The considerable land degradation including loss of nutrients owing to removal of animal
manure a crop residues for use as a fuel and cattle feed
2. The low quality and availability of water, as a result of which only about one-fifth of the
population has access to safe water.
3. The rapidly growing urban environmental problems including lack of sanitary facilities,
inadequate refuse collection, and low standard of housing.

In essence, this environmental assessment is not anti-development rather it is a means to maintain the
environment and for the sustainable development of the country's resources.

In environmental assessment there are two main level of assessment. One for impact of projects i.e.,
Environmental Impact Assessment (EIA) and one for the impact of policies plan and program i.e.,
Strategic Environmental Assessment (SEA). The later is becoming an increasingly powerful tool to
assess the impacts at the national or regional level of existing policies and plans. In Environmental
Impact Assessment (EIA) there are four major stages to the process:
- Screening
- Scoping
- Impact Assessment and Evaluation – preparation of environmental impact statement
- Monitoring and Auditing

38
The overall Environmental Impact Assessment (EIA) process is illustrated in the following diagram

39
Figure 1: Flow chart of simplified EIA process

Actions Outcomes

Review of projects Screenin Decisions to proceed

to Assess if an EIA g with environment
is Necessary
Potential and/or impacts
Scopin
Identification of Major g of project to assessed and
Environmental impacts evaluated
of project
Impact Prediction Magnitude and significance
Assessment of impacts, and of impacts and mitigation or
and identification of Evaluation enhancement measures
Mitigation measures, and
Environmental Impact
Drafting of Statement
Preparation and Environmental
consultation of draft and Impact Statement

Public and statutory Review

of EIS, and Decision on Review and Yes or no to
whether to Proceed Decision project
Making
Monitoring of key Public reports (part of
Environmental environmental
Environmental
variables, and auditing management system and/or
against Standard/plan Monitoring &
Auditing

Screening
Screening is the initial review of a project to determine if an EIA is required. For certain types of
project it can be a mandatory requirement to undertake an EIA. For others it will be a matter for
decision by the relevant regulatory authority. For all major agricultural projects it is likely that an
EIA would be required, and desirable.

Scoping
Once a decision has been made to commence an EIA the next exercise is to assess the likely major
impacts of the project on the environment. This is known as scoping an initial environment
evaluation. This may identify very major adverse impacts of the proposed project, which mean an
outright rejection of the project. An example could be a proposed development, which would have a
major impact on the pack and be outside national policy. On the other hand the evaluation may

40
identify no possible significant adverse impact of the project. When this is the case a full EIA will
not be necessary and the project can move on to its implementation stage.

Impact Assessment &Evaluation

Following the decision to precede with a full EIA the next stage of the process is the most exhaustive
and consequently expensive part of the assessment. This is the identification and prediction of all the
environmental impact of the proposed project, their likely affects both positive and negative, and the
way to enhance or mitigate these impacts. The outcome of this stage will be a report of the
assessment; this is commonly called an Environmental Impact Statement (EIS). The typical content
 are
EIS Background
given information of project and area, including history of project and its stakeholders
below.
and beneficiaries.
 Biophysical and socio-economic environmental description of the area, and assessment of the
quality and reliability of this data.
 Review of legislative and institutional environment affecting the project.
 Assessment of significance and degree of potential impacts (positive and negative) with
ranking of importance and, where possible, a quantitative and economic evaluation. Including
the active participation of project beneficiaries and those local communities affected by
project.
 Analysis and appraisal of different project options, including a without project option.
 Description of recommended mitigation measures for negative impacts, and of measures to
enhance positive impacts.
 Recommendations or environmental monitoring, evaluation and auditing.

Depending upon the actual EIA the EIS may include recommendation on whether the project should
proceed of the changes, which should be made to its design to allow it to proceed to implementation.
The EIS should also include recommendations on environmental monitoring to take place after
project implementation.

This stage of the EIA should also be used to attempt an economic valuation of the environmental
impact, which can then be used in the appraisal of the project to help assess its overall viability.
Often this part of the EIA can be a lengthy and expensive, particularly where it is necessary to
assemble or survey baseline data. However, the investment on EIA and valuation can be more than
offset when negative impact are avoided or reduced, and positive impacts enhanced.

Monitoring & Environmental Auditing

When a project has moved to implementation the final stage of the Environmental Impact
Assessment (EIA) process, or a component of project management, is environmental auditing. This
is
41
linked to the environmental monitoring of the project. Auditing can be undertaken either by the
project itself or by an external agency. The objective of auditing is to assess the impact of the project
against established standard. For example, where an agricultural project has included a major
processing plant it could be monitoring of water quality to make sure that effluent from the plant is
not exceeding the agreed or mandatory levels. Monitoring and auditing require resources and a
commitment by the project operator and regulatory authorities.

3.3.1 TIMING OF ENVIRONMENTAL ASSESSMENT

A crucial factor with environmental assessment is when it to be made in the development of a

project. In the past the environmental assessment of a project, if it happened at all took place toward
the end of the development of the project. This would often have been after the identification, design
and financial/economic appraisal of the project. But the environmental viability of a project is
essential for a successful and sustainable project. This to undergo the preparation of project leaving
the environmental to the end of makes no sense, especially, if this assessment indicates that the
project is not environmentally viable and sustainable.

It is, therefore, important that environmental assessment of projects and project options commences
as soon as a project has been identified. This could be only an initial evaluation to rule out various
options, which have serious environmental impacts. Later as the project develops more detailed
assessments should take place alongside the more traditional economic and financial assessments of
projects. The environmental economic valuation should be a part of the overall cost benefits analysis
of a project.

3.3.2 VALUATION OF COST AND BENEFIT WITH REGARD TO ENVIRONMENT

In principle, economic analysis are to take into account all costs and benefits of a project. With
regard to environmental, impacts, however, there are two basic problems. First, environmental
impacts are often difficult to measure in physical terms. Second even when impacts can be measured
in physical terms, valuation monetary terms is difficult. In spite of such difficulties, a greater effort
needs to be made now "internalize" environmental costs and benefits by measuring them in money
terms and integrating these values in economic appraisal.

Three key issues in measuring environmental costs and benefits are discussed hereunder;
a) Determining physical impacts and relationship
b) Valuing impacts in monetary terms & discounting; and

42
 c) Risk and Uncertainty

a) Physical Impacts and Relationship

The first step in environmentally sound economic analysis is to determine the environmental and
natural resource impacts of the project or policies in question. These impacts are determined by
comparing the "with project" and the "without project" impacts. For determining physical impacts,
an economist will have to rely on the expertise of engineers, ecologists, agronomists, social
scientists, and other specialists. The task is complex in that some physical relationships may not be
known, may be stochastic or may occur only over the long-term.

b) Valuing the Impacts in Monetary Terms and Discounting

A number of conceptual approaches have been developed for valuing physical impacts and
relationships. An environmental impact can show itself in a measurable change in production or
environmental quality. Different methods are appropriate depending on the types of effects (See the
Table below). The methods and approaches discussed below are applicable or potentially applicable
in developing countries. The techniques are presented in decreasing order of reliance upon market
information, beginning with those that rely on actual market prices, and ending with survey-based
and other hypothetical methods.
Table 2 Chief Valuation Techniques
DIRECT VALUATION SURROGATE MARKET POTENTIAL EXPENDITURES
VALUES OR WILLINGNESS TO PAY
- Changes of productivity - Property values - Replacement costs
- Loss of earnings - Wage differences - Shadow project
- Defends expenditures - Travel costs - Contingent valuation
- Market goods as proxies

Market Based Methods/ Direct valuation

The primary feature of these methods is that they are based directly on market prices productivity.
They are applicable where a change in environmental quality affects actual production or production
capability.

i) Change in Productivity Approach

Development projects can affect production and productivity positively or negatively. For example, a
land management project involving soil conservation measures, may yield increased agricultural
output. The incremental output can be valued by using standard economic prices. The environmental

43
costs of reclaiming wetlands or of water pollution are now being recognized. Where these affect fish
catch either in the short-term or long-term the value of fish catch can be estimated directly by using
actual or projected market prices.

ii) Loss-of-earnings Approach

Changes in environmental quality can have significant effects on human health. Ideally, the monetary
value of health impacts should be determined by the individuals' willingness to pay for improved
health. In practice, "second best" techniques may be necessary, such as valuing earnings that are
foregone through premature death, sickness or absenteeism; and increased medical expenditures.
This approach may be relevant, for example, when considering road and industrial plant safety, and
projects that affect air pollution in major cities.

The "value of health" approach is often questioned on ethical grounds. It is argued that it
dehumanizes life, which is of infinite value. In practice, however, society implicitly places finite
values on human life and health when it makes policy and project decisions that affect environmental
quality, workers' health or safety, etc. If this were not so, we would be justified in spending all of
GDP on health improvements.

iii) Defensive or Preventive Expenditures

Individuals, firms, and governments undertake a variety of "defensive expenditures" in order to avoid
or reduce unwanted environmental effects. Environmental damages are often difficult to assess, but
defensive expenditures may be determined more easily in monetary terms than direct valuations of
the environmental good in question. Such actual expenditures indicate that individuals, firms or
governments judge the benefits greater than the costs.

Methods Based on Surrogate Market Values

The methods and techniques described in this section use market information indirectly. The
approaches discussed are the property value approach, the wage differential approach, the travel cost
method, and uses of marketed goods as surrogates for non-marketed goods. Each technique has its
particular advantages and disadvantages, as well as requirements for data and resources. The task of
the analyst is to determine which of the techniques might be applicable to a particular situation.

i) Property Value Approach

This approach, also referred to as the hedonic price technique, is a subset of the more general land
value approach. Its objective is to determine the implicit prices of specific characteristics of

44
properties. When used in environmental issues, its purpose is to place a value on improvements or
deterioration in environmental quality.
The property value approach has been used to analyze the effect of air pollution in certain areas.
Where pollution is localized, the method compares prices of houses in affected areas with houses of
equal size and similar neighborhood characteristics elsewhere in the same metropolitan area. The
approach is based on the assumption of a competitive real estate market, and its demands on
information and statistical analysis are significant; therefore, applicability to developing countries is
limited.

ii) Wages Differential Approach

This approach is based on the theory that in a competitive market the demand for labour equals the
value of the marginal product, and that the supply of labour varies with working and living
conditions in an area. A higher wage is therefore necessary to attract workers to locate in polluted
areas or to accept risky work. Again, as in the case of the property value approach, the wage
differential approach can only be followed if the labour market is very competitive. Also, the
approach reflects only private, not social, valuation of health risks.
iii) Travel Cost Approach
This approach is most often used in analyzing the economic benefits of recreational facilities in
industrial countries (parts, lakes, forests, wilderness, etc). Essentially the same approach can also be
used to value “travel time” in projects dealing with fuel wood and water collection.
The surrounding area of a site is divided into concentric zones of increasing distance, representing
increasing levels of travel cost. A survey of users should be conducted at the site to determine the
zone of origin, visitation rates, travel costs, and various socio-economic characteristics. Users close
to the site would be expected to make more use of it, because the implicit price for them, as measured
by travel costs, is lower than for more distant users.

iii) Marketed Goods as Surrogates for Non-Marketed Goods

There are situations where environmental goods have close substitutes that are marketed, and where
therefore the value to the environmental good in question can be approximated by the observed
market price. For example, the value of a non-marketed fish variety can be valued at the price of the
most similar fish being sold in local markets.

Methods Based on Potential Expenditures or Willingness-to Pay

45
Sometimes it is not possible to estimate the benefits of environmental quality protection or
improvements. In some of these cases it may be possible to estimate benefits by calculating the costs
of replacing the environmental services that have been or might be destroyed by a project, or by
estimating what people might be willing to pay (WTP) to protect an environmental asset. Once again,
however, great care needs to be exercise to avoid improper valuation.
i) Replacement Cost Approach
Under this approach, the costs of replacing a damaged asset are estimated. The estimate is not a
measure of the benefit of avoiding the damage in the first place, since damage costs may be higher or
lower than the replacement cost. However, it is an appropriate technique if there is compelling reason
to restore the damaged asset, or certainty that it will be restored. The replacement cost approach has
been used to estimate the benefits of erosion prevention measures by calculating the cost of the
fertilizer that would be needed to replace the nutrients lost through soil erosion. The method applies
only if, in the absence of erosion control measures, the fertilizer would actually be applied.ii)
Shadow Project Approach
Used for evaluating projects with negative environmental impacts, this approach involves the design
and costing of one or more “shadow projects” that would provide substitute environmental services
to compensate for the loss of the original assets. This approach is essentially the same as the
replacement cost approach; it is being mentioned increasingly as a way to make operational the
concept of sustainability at the project level. It assumes a constraint for maintaining environmental
capital intact, and could therefore be most relevant when “critical” environmental assets are at risk.
iii) Contingent Valuation Method
In the absence of market information about people’s preferences, the contingent valuation method
tries to identify them by posing direct questions about willingness to pay. Basically, it asks people
what they are willing to pay for a benefit, and/or what they are willing to accept as compensation for
tolerating a cost. This process of “asking” may be either through a direct questionnaire/survey, or by
experimental techniques in which subjects respond to various stimuli in “laboratory” conditions.
What sought are personal valuations by the respondents for increases or decrease in the quantity of
some good, contingent upon a hypothetical market.

The continent valuation method has many shortcomings, including problems in designing,
implementing and interpreting questionnaires. While its applicability may be limited, there is now
considerable experience in applying this survey-based approach in developing countries, e.g., to
evaluate the quality of supply of potable water and electricity services. In certain circumstances, the

46
contingent valuation method may be the only available technique for benefit estimation, and can be
applied to common property resources, to amenity resources with scenic, ecological or other
characteristics, or to other situations where market information is not available. Caution should be
exercised in seeking to place a value on the more abstract benefits of environmental assets, such as
existence or intrinsic value.

N.B: The issue of discounting will be discussed under financial analysis

c) Issues of Risk and Uncertainty
Projects and policies alike involve risks and uncertainties. Risks are involved when probabilities can
be assigned to the likelihood of an event occurring, such as an industrial accident. Uncertainty
describes a situation where little is known about future impacts and where therefore no probabilities
can be assigned to certain outcomes, or where even the outcomes are so novel that they cannot be
anticipated.
Risk can be insured against and treated as a cost, but uncertainty defies actuarial principles because
of novelty of outcomes. Uncertainty is especially important in environmental issues. As projects
grow larger in scale and introduce novel substances into the environment, the category of risk
becomes less relevant and the category of uncertain more relevant. The proper response to risk is to
count it as a cost in expected value formulations. The proper response to uncertainty is likely a policy
of general caution: if one cannot see very far ahead, slow down.

3.4 Financial Analysis

Financial analysis is analytical work required to identify the critical variables which are useful for
likely to determine the success or failure of an investment. Its concern is to determine, analyze and
interpret all the financial consequences of an investment that might be relevant to and significant for
the investment and financing decisions. For this purpose different statements such as resource flow
and financial statements how then are and financial analysis tools (NPV, IRR and payback period)
are discussed in detail.

3.4.1 PURPOSE OF FINANCIAL ANALYSIS IN PROJECT PLANNING

Investors transfer the liquid financial resources (equity, borrowed money or both) into production
assets with the objective of producing and obtaining future benefits. This process is known as
investment, a long term commitment of scarce resources.

47
Project financing includes the design of proper financial structure, considering the adequacy of the
financial plan, and the optimization of project financing from the different actors or beneficiaries
point of view. Therefore, the scope and objective of financial analysis are to determine, analyze and
interpret all the financial consequences of an investment that might be relevant for and significant for
the investment and financing decisions.

Financial analysis is essentially undertaken for the following purposes:

1. It provides an adequate financing plan for the proposed investment
2. It determines the profitability of a project
3. It assists in planning the operation and control of the project by providing management
information to both internal and external users
4. It advises on methods of improving the financial viability of a project entity
Therefore, the purpose of financial analysis is not just to document the expected impact of the
project, liquidity, credit worthiness, financial efficiency, etc, of the various agents involved; it should
also be part of the process of project design itself.

3.4.2 MEASURES OF PROJECT WORTH

Measures of project worth are measures that tell you whether a project is worth undertaking form a
particular viewpoint. All such measures are concerned with the question "are the benefits greater than
the costs?" There are different ways of measuring project worth, which may fall under two
categories, that is discounting cash flow methods and non discounted (traditional) methods. They are
briefly explained here in after.

Before we are going to discuss non-discounted and discounted financial analysis techniques, let us discuss
briefly the concepts of discounting and compounding. Money is one of the basic resources of an
organization that has a time value. The time delay between an outlay and its effect is the main reason for
discounting and compounding future benefits and costs.

To allow for the changes in the time value of money, the terms "present value" and "future value" are
used. To calculate the present value of future costs and benefits their future values are "discounted" –
reduced from constant price values – back to the present using a discount rate. The concept of
compounding is the opposite of discounting whereby in compounding, the present value grows to a future
value because of the accumulation of interest.

Compound Interest
Compound interest can be calculated using the following formula:

48
Future value = Present value x Compound
factor

Where r = annual interest

rate t = time in years
Fv = future value
FV = PV (1 + r) t PV = present value

Example: What will be the value of Br. 100,000 deposit in an account which pays 10% interest
compounded for a period of three years time?

Solution:

PV = Br.

100,000 r = 10%

t = 3 years

FV = 100,000 (1 + 0.1)3

= 100,000 (1.1)3

= 133,100 Br

This is the amount that the account accumulates after three years the difference between the original
sum of money 100,000 Br. and 133,100 i.e., 33, 100 birr is the interest earned during the period.

Discounting
The discount rate is the reciprocal of the compound factor and it is given by the following formula:

PV = FV or FV (1 + r)-t

(1 + r) t

Example: what will be the present value of the profit of Br. 100,000 generated in the third year
of a project if the discount rate is 10%?
Solution: Fv = 100,000 Br. r = 10%
t = 3 years Pv = ?
PV = 100,000 (1.1)-3
= Br. 75,131.5

49
In a net shell, when you have streams of costs and benefits (cash inflows) for a project, and you
also have a measure of time preference (i.e., rate of discount) we can then discount the cost and
benefit streams to arrive at their discounted value as it is shown above. This procedure is often
described as "Discounted Cash Flows" or DCF.
Non-Discounted Measure of Project Worth
A) Payback Period
Payback period is one of the simplest methods to find out the period by which the investment on the
project may be recovered from the net cash inflows, i.e., gross cash inflow less the cash outflows. In
short it is defined as the period required recovering the original investment cost. Payback period
starts with a preconceived notion that the management wants to recover the cost of investment within
a "specific period". When the analysis under such system shows that the payback period is less than
such "specified period", decision may be taken in favor of the investment for such project.

The basic drawbacks of this method of financial analysis are:

1) The payback period is a very crude measure of project worth because it completely ignores
benefits/ cash flows after the period when the initial investment has been repaid. Hence, it
would be a very unreliable means for comparing two different investments with different
time profiles. It discriminates heavily against projects with a long gestation period.
2) It ignores the time value of money
3) It is unsuitable while comparing the payback periods of two or more projects where the net
cash inflows are of widely different amounts for different projects. Projects with initial lower
earnings but with very high profitability in later years may be rejected as the payback period
will be longer.
4) It requires an estimation of a safe period, in reality that varies between types of industry. For
example, in heavy industry the payback period is very long.

In spite of all the drawbacks mentioned above, this method is easy to understand, quickly in
calculations and emphasizes in liquidity. The decision on "short term" investment can be taken based
on this method of financial analysis. There are two methods in use to calculate the payback period.

 Uniform Cash flows

Where the annual cash flows are uniform, payback period can be calculated using the formula:
PP = Original Investment
Annual Cash Flows

50
Example: A project requires an investment of Br. 200,000. It is expected to generate an annual cash flow
of Br. 50,000 per year over the life of the project. How long will it take to recover the investment?

PP = Original Investment
Annual Cash Flows
= 200,000 Br
50,000

= 4 Years

 Unequal cash flows: In this situation the payback period is calculated as:
Payback period = E + B/C
Where
E = number of years immediately preceding the
year of final recovery
B = the balance amount to be
recovered C = cash flow during the final
recovery

Example: A company is considering investing on a particular project. The alternative projects available
are: Project A that costs Br. 100,000, and Project B that Costs Br. 70,000. The net cash inflows estimates
are as follows:
Net Cash Inflow

Year Project A Project B

1 30,000 7,000
2 30,000 15,000
3 35,000 20,000
4 35,000 56,000
5 40,000 45,000
Which project is good?
Solution:
Project A Project B
Year Net cash inflow Accumulated Net Net cash inflow Accumulated Net
cash inflow cash inflow
1 30,000 30,000 7,000 7,000
2 30,000 60,000 15,000 22,000
3 35,000 95,000 20,000 42,000
4 35,000 130,000 56,000 98,000

51
 5 40,000 170,000 45,000 143,000

Payback period for Project A:

Payback = 3 years + 5000*

period 35,000
= 3.14 year or 3 years and 2 months
Payback period for Project B
PP = 3 years + 28,000
56,000
= 3.5 year or 3 years and 6 months
Note: * represent the balance to be recovered from the cash inflow in period four; i.e.,
100,000 – 95,000 =5,000
B) Simple Rate of Return (SRR)
SRR is defined as the ratio of net profit in a normal year of full operation or production to the original
investment outlay in the project. This measure is sometimes known as the return on equity capital (ROE)
and is defined as a percentage for year by:
ROEt = MPt x 100
Qt

Where: ROE = Return on equity

capital MP= Net profit
Q = Value of equity capital

C) Benefit cost ratio (B/C)

This is a measure of efficiency and used for comparison of different projects. It is given by the
formula:
B/C = Benefits
Cost of the
project
In general, non-discounted measures of project worth can be regarded as simplified short cuts that
can be used for rough approximations and decision making on small investments but they are not
appropriate quick look at on a feasibility viability of the project before you go to detail analysis of
the project carried out.

Discounted Measure of Project Worth

52
The commonly used discounting methods are:

53
 - Net Present Value (NPV)
- Internal Rate of Return (IRR)
and These are discussed in brief below.
i) Net Present Value (NPV): is the net sum of total discounted benefits (cash inflows) and total
discounted costs. It represents the present worth of an investment in excess of the investment itself.
The NPV method is a system of finding out the excess (or short) of the present value of the earnings
from the investments over and above the present value of the investment itself.

Steps to find out the NPV

1. Find the project costs
2. Find the future cash flows as estimated for the projected business
3. Select an appropriate rate and a period to be considered for such evaluation to find the present
value of the future cash flows for the period by discounting by the selected rate
4. Find out the difference between the present value of cash inflows (net) and the investment cost
(present value of investments over the life of the project).This difference represents NPV.
This calculation can be represented algebraically as:

NPV =  CFt Where:

(1  r)t  C
CF = Cash inflows at different
0
periods r = discounting rate
C0 = cash outflow in the beginning

NPV = Net Present Value

t = time period
The decision rule here is to accept a project if the NPV is positive and reject it if it is negative. A project
whose NPV approaching zero is a marginal project. The planner has to re modify, otherwise it will be
very risk to take such projects.

Comments on the NPV Method

1. The NPV is easy to understand and calculate from the figures available in the project schedule.
2. The basic drawbacks in this method are:
 Estimation of a discounting rate, which can be very much subjective, or need to be
obtained externally such as National Bank.

54
  The measure fails to indicate which project uses capital more efficiently or which
projects are closer to the margin of acceptability.
Example 1
AMA Company is considering investing in a particular project. The initial investment cost is Br. 100,000.
It is expected that the project may generate a benefit for 5 years as shown below:

Year Operating cost Annual cash

inflow
1 6,000 Br. 20,000

2 10,000 30,000

3 2,000 40,000

4 1,000 40,000
5 1,000 35,000

The discounting rate is 10%

Required: Calculate the NPV
The approach is discounting the cost and revenue streams separately. This is shown as follows.

Year Cost Revenue (Cash inflows) PV of Cost PV of Revenue

0 Br. 100,000 -- Br. 100,000 --
1 6,000 Br. 20,000 5,454.6 Br. 18,181.8
2 10,000 30,000 8,264.5 24,793.4
3 2,000 40,000 1502.6 30,052.6
4 1,000 40,000 683 27,320.5
5 1,000 35,000 621 21732.2
Total 116525.7 122080

Net present value of the project = PV of Revenue – PV of Costs

=122,080 – 116,525.7
= Br. 5554.3

Decision: If you are talking about only one project, the decision is to accept this project since its NPV
is positive.

Example 2

A firm is considering investing in a project which costs 6,000 Br and has the following cash flows:

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 Year 1 2 3 4

Net Cash 1500 3000 2000 2500

flow

The cost of capital is 10%and the project has no salvage value. Using the NPV method, advise the firm on
whether to invest in the project.

Year Net Cash PV of net

Flow cash flow

1 1500 1363.65

2 3000 2479.20

3 2000 1502.60

4 2500 1707.50
Total= 7053
NPV= Discounted net cash flow-cost

=7053-6000=1053

Decision: Accept the project since NPV >0

ii) Internal Rate of Return (IRR): is defined as the discount rate the net present value is zero. IRR
method finds out the rate at which – when applied on future cash inflows – the present value of
such inflows taken together should equal with the present value of the cost of investment. It is
called "Internal", as it is purely related to the return of` the particular projected investment only. In
other words it is the rate at which the project investment is just recovered. In essence it measures
the efficiency of capital. To calculate IRR we can use interpolation method using the following
formula:

Lower Difference
discount between
IRR = + discount X MPVs at lower discount rate
rate (DR) Absolute differences of MPVs at two discount rates

As you can see in the formula, you need to have two net present values i.e., positive and negative NPVs
that can be determined by the trial and error method. The higher the discount rate is the lower NPV and
the lower the discount rate is the higher the NPV. Interpretation should be attempted arithmetically
over a range of discount rates.

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A project's NPV varies with the discount rate usually the higher the discount rate then the smaller the
NPV. NPV method is used widely because it provides an absolute measure of the surplus generated by the
project. A project is acceptable at a given discount rate if the NPV is positive.

Steps in the IRR trial and error calculation method

 Compute the NPV of the project using an arbitrary selected discount rate.

 If the NPV so computed is positive then try a higher rate and if negative try a lower rate.

 After having two discount rates (+ ve and – ve) apply the formula.

Decision Rule: Accept if IRR>the rate of return (cost of

capital) Reject in IRR<the rate of return (cost

of capital)

If IRR= the rate of return (cost of capital) then it is a marginal project

Example: A project has the following cash flows

Year 1 2 3 4

Cash Flow 300 400 700 900

The cost of the project is 1500 Br. Determine whether project is acceptable if the cost of capital is 18%
using the IRR method.

We first select an arbitrary discount rate say 9% and compute the NPV

Year Cash Flow PVIF (9%) PV

1 300 0.9174 275.22

2 400 0.8417 336.68

3 700 0.7722 540.54

4 900 0.7084 637.56

PV 1790.00

Less Cost (1500)

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 NPV at 9% 290.00

Since, NPV at 9% is positive and large we select another discount rate larger than 9%, say 15%

Year Cash Flow PVIF (15%) PV

1 300 0.8696 260.88

2 400 0.7561 302.44
3 700 0.6575 460.25

4 900 0.5718 514.62

PV 1538.19
Less Cost (1500)
NPV at 15% 38.19
Since, NPV at 15% is positive but not large; we select a slightly higher rate, say, 18%.

Year Cash Flow PVIF (18%) PV

1 300 0.8475 254.25

2 400 0.7182 287.28

3 700 0.6086 426.02

4 900 0.5158 462.22

PV 1431.77

Less Cost (1500)

NPV at 18% -68.23

Since NPV at 18 is negative, IRR therefore lies between 15% and 18%, and since zero NPV will the
between 38.19 and -68.23, to get the correct (exact) IRR we have to interpolate between 15% and 18%
using interpolation formula

IRR  15  (18 
38.19   16.08%
15)
 0 
38.19  (68.23
 

Decision: Reject the project since IRR is less than the required rate of return (cost of capital)

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3.5 Socio-Economic Analysis
Socio-Economic analysis is one step forward in the project planning effort. Because as compared to
financial analysis, which should assess the impact of a project on the income of its owners, economic
analysis is a form of more general tool of cost benefit analysis. The use of the word "economic"
implies the analysis is undertaken is from the point of view of the nation or the economy as a whole.
It can be seen as a cost benefit analysis from the social and national perspective. It ascertains the
overall country impact of a project. In other words, it is the measure of the costs and benefits of a
project to the society. The exercise of project appraisal is not accomplished till the proposed project
is also viewed from the economic viewpoint. Therefore, this unit focuses on economic analysis and
items included in it.

3.5.1 OBJECTIVES/REASONS FOR ECONOMIC ANALYSIS

In project planning there are two main objectives to economic analysis. These are:
1. to provide information for making decisions on the acceptability of projects from the
national point of view, and
2. To provide information of value for project design and planning, macroeconomic
planning and economic research.

Economic analysis broadens the analysis from confining attention to the project itself to
investigating the impact of the project on the national economy. Economic analysis is the core of
project analysis and evaluation.

Economic analysis substitutes shadow price (economic prices) for market prices because market
prices do not reflect their true or scarcity prices. Regardless of their difference, financial analysis
is the base for economic analysis. It provides the necessary information to be used for economic
analysis.

Social Cost Benefit Analysis/Economic analysis is done because of the following reasons.
1. Inflation: is a general price increase of commodities (Inputs and outputs). When high
degree of inflation prevails in any economy, the project's inputs and outputs do not reflect

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 their real value. Therefore, the price of these inputs and outputs should be adjusted using
the world price by conducting economic analysis.
2. Currency over valuation: when the foreign currency is overvalued (eg., dollar), most
developing countries are exercising devaluation of their currency in order to reflect the
world price. For example, our birr is depreciated from time to time whenever the value of
dollar is appreciating. ($1 = Br. 8.00, $1 = Br. 8.65 etc.)
3. Existence of under employment: in developed countries like Ethiopia, the domestic
prices are distorted and do not reflect the real value of inputs and outputs. In other words,
the market prices and economic prices are not the same. One of the highly distorted
markets is the labor market. Unskilled and semi-skilled labor market is highly affected
because workers are paid less and the payment is employees not the same for all doing
the same job. Therefore, for economic analysis purpose this distortion should be adjusted.
4. Existence of income/wealth inequality: due to this inequality price may not reflect the
social equalities. As a result project analysts shift to apply social pricing techniques (that
is shadow pricing techniques).
5. Externalities: are costs and benefits to the economy as a whole and that are attributed to
the project but are not taken in to account in estimating quantities and values for the
project inputs and outputs. Since they are not paid for by a particular firm, financial
analysts ignore them. But someone has covered their cost (government), thus their value
should be included in the economic pricing technique.
6. Existence of tariffs, customs and duties: existence of these restrictions and impositions
by the government may increase the price of commodities. This cost needs to be excluded
in the economic analysis because it does not reflect the commitment of real resources.

The existence of the above mentioned factors demands economic analysis so that the value of
inputs and outputs of a project can reflect its real value. Markets like commodity market, labor
market, foreign exchange and capital markets are highly distorted in developing countries.
Therefore, adjustment of price to reflect the real cost of resources should be made using shadow
prices, which is a set of prices that better reflect the opportunity costs of goods and services in
their best use. The objective of economic analysis is utilization or best use of the scarce
resources of a nation.

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 Chapter Four
Project Implementation, Monitoring and Evaluation

4.1 IMPLEMENTATION

The importance of implementation phase of a project is not over emphasized because a nicely
designed project may fail or the expected benefit may not be realized due to poor
implementation. Implementation begins immediately after the final decision on the project and
ends when it starts rendering the benefits envisaged. While in earlier stages of project planning
there was more thinking and less action, in this stage more action and less thinking is needed. It
is a point at which conclusions are reached and the decisions made are put into action.
4.1.1 PRE-REQUISITES FOR SUCCESSFUL PROJECTS IMPLEMENTATION

Time and cost over runs are common in every country's is development projects. Due to such
time and cost over-runs, projects tend to become uneconomical, resources are not available to
support other projects, and economic development is adversely affected. What can be done to
minimize this problem and thereby improve the prospects of successful completion of projects?
While a lot of things can be done to achieve their goal, the more important ones appear to be as
follows:
1. Adequate Formation
Often project formulation is deficient because of one or more of the following shortcomings:
- superficial field investigation
- poor assessment of input requirements
- omission of project linkages
- poor judgments because of lack of experience and expertise
- deliberate over estimation of benefits and under estimation of costs
- undue hurry to get started.

Therefore, managers must take care to avoid the above deficiencies sot that the appraisal and
formulation of the project is thorough, adequate, and meaningful.

2. Sound project organization

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A sound organization for implementing the project is critical to its success. The organization
should give attention to the human side of the project, rewards and penalties should be related to
performance and authority and responsibility should be equivalent.
3. Proper implementation planning
Once the investment decision is taken and often even while the formulation and appraisal are
being done – it is necessary to do detailed implementation planning before commencing the
actual implementation.
4. Advance action
When the project appears to be viable and desirable, advance action on the following activities
may be initiated:
- acquisition of land
- securing essential clearances
- identifying technical collaborators/consultants
- arranging for infrastructure facilities
- preliminary design and engineering, and
- calling of tenders.
5. Timely availability of funds
Once the project is approved, adequate funds must be made available to meet its requirements as
per the plan of implementation – it would be highly desirable if funds are provided even before
the final approval to initiate advance action.

6. Judicious equipment tendering and procurement

In order to avoid time and cost over runs it is important to place a tender and choose the right
supplier of the necessary input of the project.
7. Better contract management
Since the substantial portion of a project is typically executed through contracts, the proper
management of contracts is critical to the successful implementation of the project.
8. Effective monitoring
In order to keep a tab on the progress of the project, a system of monitoring must be established.
This helps in:
- anticipating deviations from the implementation plan

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 - analyzing emerging problems
- taking corrective action

4.2 MONITORING
Monitoring is a timely gathering of information on project inputs, outputs and complementary
activities that record the progress of a project towards the achievement of its objectives.
Monitoring is not a onetime activity rather it is done throughout the life of the project. It
compares the actual outputs and inputs with the expected or planned levels of input to be used
and output to be produced.
Monitoring result should alert project managers and policy makers to actual and potential
implementation problems requiring connective action. It requires simple, clearly and easily
operational systems. Monitoring can be done through field visits and interviews. Regardless of
the way it is going to be done, the whole purpose of monitoring system is to improve the effects
of the project management team, while they are involved in putting the project to action as per
the schedule.
In developing a system of monitoring, the following points should be taken into consideration:
a) it should focus sharply on the critical aspects of project implementation
b) it must lay more emphasis on physical milestones and not on financial targets
c) it must be kept relatively simple of made over-complicated, it may lead to
redundant paper work end diversion of resources
d) it must be viewed that monitoring is not an end in itself rather as a means to
implement the project successfully.
4.3 EVALUATION
Evaluation is primarily concerned with comparing the actual project efforts and impacts against
the established standard/plans in order to determine the variance. Mostly it is considered as a
post action. But it can be considered as both ongoing and ex-post action of the project's control
effort. The ongoing evaluation is done throughout the life of the project but the ex-post
evaluation is an action taken at the final performance of the project. The ex-post
analysis/evaluation is inadequate for project control because it is a backward looking rather than
forward looking and it does not use the data effectively to provide integrated control. Ex-
post/post audit action of a project control:

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 - provide a documented log of experience that may be valuable in improving future
decision making
- enable the firm in identifying individual with superior abilities in planning and
forecasting
- help in discovering systematic biases in judgment
- induce healthy caution among project sponsors, and
- serve as a useful training ground for promising executives who need broader business
experience and exposure.
Evaluation is mainly concerned with determining whether the planned benefits of the project
have materialized and distributed to the beneficiaries of the project. Evaluation takes longer time
than monitoring. Similarly, it also requires more specialist skills both from within and outside the
project.
WHY DO DEVELOPMENT PROJECTS FAIL?

In most developing countries the failure rates of projects out weigh those, which are successful.
In most cases the following are the basic reasons for project failure.

1. Poor project planning and preparation

2. Delay in implementation
3. Cost and time over runs
4. Shortage of raw materials
5. Shortage of skilled manpower
6. Lack of coordination among different project implementers or executive agencies like
electric power suppliers, road agencies, water and sewerage authority etc
7. Lack of community participation in project planning and implementation. Project
initiators should see in the first place whether the project is demand – driven or not.
Development projects must be "felt-need of the society" rather than a stranger to a
particular community of the project area. Otherwise, the project will not achieve its
intended purpose. In general, project to be successfully implemented; it should consider
all social issues.

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